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Friday, April 22, 2011

The cost of bipartisan bickering over US budget

WHEN it comes to the worrying state of public finances in the United States, the writing has been on the wall for years.

The latest warning by credit ratings agency Standard & Poor's (S&P), which on Monday changed its long-term outlook on American debt from 'stable' to 'negative' for the first time, technically says nothing that is not already known.

The agency points out, for instance, that 'US policymakers might not reach an agreement on how to address medium and long-term budgetary challenges by 2013'. Anyone who has been following the fractious debate on this issue would not come to a different conclusion.

S&P's announcement doesn't alter market fundamentals either. Yes, global stocks slid on the news, but there were other market concerns in play as well, such as the debt crisis in Europe and inflation in China.

Ultimately, there is just no credible alternative to US Treasuries at the moment, even if panicky institutional investors are looking to diversify their investments.

The agency's economists must know this as well. So why go out on a limb like this and draw the collective scorn of their peers in the US?

One possible explanation is that the message is aimed not at economists, but rather the warring factions in Washington, particularly freshmen Republican lawmakers who are spoiling for a protracted fight over the country's purse strings. This could account for why the seven-page ratings report came with a 10-page explanation.

By injecting itself publicly into the conversation and going well beyond the usual polite warnings issued by institutions such as the International Monetary Fund, S&P's blunt message to the Democrats and Republicans seems to be this: Don't assume the partisan warfare is risk free, and understand that the ensuing gridlock will have real, not abstract, consequences.

To drive home its point, S&P warns specifically that there is a one-in-three chance that America could lose its top credit rating over the next two years if lawmakers do not come up with a credible plan to bring down the budget deficits.

The US has been given a triple A rating ever since the agency began its ratings 70 years ago. Losing this top rating would mean higher borrowing costs, a development that would worsen the budget deficit, which is expected to hit US$1.65 trillion (S$2 trillion) this year. The US national debt is already at a record US$14 trillion.

This in turn weakens Washington's ability to deal with future financial crises, and the needs of its own ageing population.

The political elites in Washington are not unaware of the problem. President Barack Obama and the Republican party's rising star, Mr Paul Ryan, have in fact used blunter language than S&P when talking about the long-term fallout.

Mr Obama warned in a speech last week: 'Even after our economy recovers, our government will still be on track to spend more money than it takes in throughout this decade and beyond.

'By 2025, the amount of taxes we currently pay will only be enough to finance our health-care programmes, social security, and the interest we owe on our debt. That's it. Every other national priority - education, transportation, even national security - will have to be paid for with borrowed money.'

Mr Ryan, who chairs the budget committee of the lower legislative Chamber, was no less candid, saying: 'The economic effects of a debt crisis on the US would be far worse than what the nation experienced during the financial crisis of 2008... absent a bailout, the only solutions to a debt crisis would be truly painful: massive tax increases, sudden and disruptive cuts to vital programmes, runaway inflation, or all three.'

But while they agree on the seriousness of the problem, their proposed solutions cannot be more different.

Mr Ryan's plan to slash the deficit by US$4.4 trillion over a 10-year period essentially calls for a major scaling back of the welfare state. This would involve eliminating two major government-run medical programmes for the poor and the elderly, and major cutbacks on social welfare benefits - policies which no Democratic leader can agree with.

To jump-start economic growth, he proposes to extend tax breaks for the wealthy and corporations so that they would be motivated to invest and create more jobs.

Mr Obama countered with what he called a more 'balanced' proposal to cut US$4 trillion over 12 years that would still allow the country to preserve its current social welfare system, albeit with some painful reforms. To increase government revenue, however, he would raise taxes on the rich - a non-starter for Republicans who are against tax hikes of any sort.

The duelling plans reflect the deep philosophical differences between the two political parties. Conventional wisdom in Washington suggests that this argument can be settled only at the voting booth next November when the presidential and legislative elections are held.

No doubt the point of having elections in the first place is to settle these fundamental differences in a peaceful manner. That's what democracies are meant to do. But at the same time, a serious solution to the fiscal crisis takes time to implement and demands long-term commitment from both sides. It simply cannot be a one-sided approach that one party undertakes, which the other party tries to overturn.

As the S&P report rightfully points out: 'For any plan to be credible, we believe that it would need to secure support from a cross-section of leaders in both political parties.'

Mr Obama has reacted by maintaining that the Democrats and Republicans can reach a deal. US Treasury Secretary Timothy Geithner also insists in new interviews that the prospects for a bipartisan deal are better than ever.

Let's hope they are right, and that the S&P's provocative move doesn't end up being ammunition for an uglier political battle in the months ahead.